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Federal Reserve Bank of St. Louis
Working Paper Series
Which continuoustime model is most appropriate for
exchange rates?
Deniz Erdemlioglu
Sébastien Laurent
and
Christopher J. Neely
Working Paper 2013024A
http://research.stlouisfed.org/wp/2013/2013024.pdf
August 2013
FEDERAL RESERVE BANK OF ST. LOUIS
Research Division
P.O. Box 442
St. Louis, MO 63166
______________________________________________________________________________________
The views expressed are those of the individual authors and do not necessarily reflect official positions of
the Federal Reserve Bank of St. Louis, the Federal Reserve System, or the Board of Governors.
Federal Reserve Bank of St. Louis Working Papers are preliminary materials circulated to stimulate
discussion and critical comment. References in publications to Federal Reserve Bank of St. Louis Working
Papers (other than an acknowledgment that the writer has had access to unpublished material) should be
cleared with the author or authors.
Which continuoustime model is most appropriate for exchange rates?
6
Deniz Erdemlioglu
∗,a
, S´ebastien Laurent
b
, Christopher J. Neely
c
a
I
´
ESEG School of Management, Lille, France.
b
IAE Aix en Provence and Greqam.
c
Research Division, Federal Reserve Bank of St. Louis, USA.
Abstract
This paper attempts to realistically model the underlying exchange rate data generating process. We ask
what types of diﬀusion or jump features are most appropriate. The most plausible model for 1minute
data features Brownian motion and Poisson jumps but not inﬁnite activity jumps. Modeling periodic
volatility is necessary to accurately identify the frequency of jump occurrences and their locations. We
propose a twostage method to capture the eﬀects of these periodic volatility patterns. Simulations
show that microstructure noise does not signiﬁcantly impair the statistical tests for jumps and diﬀusion
behavior.
Key words: Exchange rates, Brownian motion, Volatility, Jumps, Intraday Periodicity,
Highfrequency data
JEL: C15, F31, G01
1. Introduction
Which statistical model realistically describes how ﬁnancial asset prices evolve over time? Probably,
the ﬁrst attempt to answer this question goes back to 1900s, when Bachelier (1900) proposed mod
eling stock returns with the “Brownian motion”. Since the seminal work of Merton (1976), however,
researchers have turned their attention to jumps in asset prices. From an economic standpoint, the
eﬃcient markets hypothesis implies that asset prices should react rapidly to news surprises to pre
vent riskadjusted proﬁt opportunities. Decomposing volatility into jumps and timevarying diﬀusion
volatility is important because these two components imply diﬀerent modeling and hedging strategies
(Bollerslev and Todorov, 2011a,b). Also, while persistent timevarying diﬀusion volatility would help
forecast future volatility, jumps might contain no predictive information about volatility or even distort
volatility forecasts (Neely, 1999; Andersen et al., 2007a). Therefore, one must model jumps to better
explain asset price dynamics.
One popular class of models that incorporate both Brownian motion and jumps is known as the
6
The views expressed in this paper are solely those of the authors and do not necessarily reﬂect those of the Federal
Reserve Bank of St. Louis or the Federal Reserve System.
∗
Corresponding author. I
´
ESEG School of Management, 3 Rue de la Digue, Lille, France. Tel: + 32.81.724889. Fax:
+ 32.81.724840.
Email addresses: deniz.erdemlioglu@fundp.ac.be (Deniz Erdemlioglu), s.laurent@maastrichtuniversity.nl
(S´ebastien Laurent), neely@stls.frb.org (Christopher J. Neely)
Brownian SemiMartingale with FiniteActivity Jumps (hereafter denoted BSMFAJ) model.
1
This class
of models features two main components: i) a diﬀusion—Brownian—component to capture the smooth
variation of the price process, and ii) a jump component to account for the discontinuities in the price
trajectories. These models exhibit ﬁniteactivity jump intensity, which implies a ﬁnite number of jumps
in any interval of time. The compound Poisson process, which exhibits relatively rare and large jumps,
is one example of this class. Andersen et al. (2007b) cite several authors who argue that BSMFAJ
realistically models many asset prices.
More recent studies show that BSMFAJ models fail to approximate the jump dynamics of some
asset prices, however. In particular, the ﬁniteactivity jump component of BSMFAJ models may be
too restrictive: It allows only relatively rare and large jumps, despite the fact that highfrequency
ﬁnancial data might show many small jumps (A¨ıtSahalia and Jacod, 2011). Lee and Hannig (2010)
document that neither diﬀusion component nor Poissontype jumps adequately describe frequent and
small jump dynamics. Therefore, the literature (see e.g. Madan et al., 1998 and Carr et al., 2002) has
introduced a new class of models with more general jump structures. These Brownian SemiMartingale
with InﬁniteActivity Jumps (hereafter denoted BSMIAJ) models include inﬁniteactivity L´evy processes
(Cont and Tankov, 2004).
2
Under the BSMIAJ model, the diﬀusion component captures the smooth
price variation and the jump component captures both rare and large jumps—potentially caused by
important macro news (Lahaye et al., 2011), as well as frequent and small ones that create risk for high
frequency trading strategies (A¨ıtSahalia and Jacod, 2012): jumps can arrive inﬁnitely often in BSMIAJ
models (Geman, 2002). Li et al. (2012, 2008) show that BSMIAJ models describe stock returns better
than BSMFAJ models.
3
Our paper thus investigates which continuoustime model best describes intraday exchange rate
ﬂuctuations? We address the following research questions:
• Does an appropriate model need Brownian motion? (Testing for Brownian motion)
• Are jumps present in the exchange rates? (Testing for jumps)
• If so, do exchange rate jumps have ﬁnite or inﬁniteactivity? (Testing for inﬁniteactivity)
• If jumps are present, how frequent or active are they? Which jump process is compatible for
intraday exchange rate series? (Estimating jump activity)
• What fraction of the quadratic variation is due to the Brownian motion and jumps? (Relative
magnitude of the components)
The answers have important economic implications. For instance, a BSM model—with only contin
uous components—generates diﬀerent risk measures (and premia) than BSMFAJ or BSMIAJ models
(Bollerslev and Todorov, 2011a,b; Drechsler and Yaron, 2011). As Back (1991) shows, consumption
based asset pricing models (CCAPM) rely on the continuous part of the returns and hence only char
1
Semimartingale models are quite useful in ﬁnancial economics and continuoustime ﬁnance because they rule out
arbitrage opportunities (see Back, 1991).
2
The literature studying inﬁniteactivity L´evy processes is young but growing rapidly. Examples include the works of
A¨ıtSahalia and Jacod (2009a,b, 2010, 2012), Todorov and Tauchen (2006), A¨ıtSahalia (2004), Carr and Wu (2003, 2004,
2007), Lee and Hannig (2010), Huang and Wu (2004), Carr and Madan (1998), and Bakshi et al. (2008), among others.
3
It is worth noting that BSMIAJ models can exclude the ﬁnite activity jump component so that only inﬁnite activity
jump component represents the price discontinuities.
2
acterize the diﬀusion risk.
4
Moreover, although BSMFAJ model captures relatively rare jump events,
BSMIAJ can represent frequent small exchange rate moves (A¨ıtSahalia and Jacod, 2012; Carr et al.,
2002).
Few papers address these issues in exchange rate applications. The papers most closely related to
the present paper are those of Todorov and Tauchen (2010) and Cont and Mancini (2011), who also
studied the characteristics of foreign exchange data generating processes, focusing on jump activity and
jump variation, respectively. We conﬁrm some ﬁndings of these two papers. Speciﬁcally, both papers
use the BlumenthalGetoor index to estimate jump activity and thus to argue that Brownian motion is
present in foreign exchange data. We use power variation measures to conﬁrm these results. We also
conﬁrm Cont and Mancini’s (2011) ﬁnding of ﬁnite jump variation with estimates of jump intensity.
Our work extends and complements those papers in its methods and in inference, however. Method
ologically, this paper extends A¨ıtSahalia and Jacod (2012) to the foreign exchange market. We use
a ﬂexible testing methodology, along with a long sample of higher frequency (1minute) data that
should provide better test properties than the 5minute data used in Todorov and Tauchen (2010) and
Cont and Mancini (2011), on three exchange rates. In addition, we explicitly account for market mi
crostructure noise and intraday periodicity in volatility. These methodological improvements provide ad
ditional insights into the foreign exchange data generating process. For example, Todorov and Tauchen
(2010) concludes that BrownianplusPoissonjumps model might be misspeciﬁed, although they stress
that this inference depends on the sampling frequency and testing technique. Using higher frequency
data and better tests, we show that a Brownian plus compound Poisson jumps model is indeed plausible.
In addition, our testing procedures allow us to consider whether jumps are appropriate components of
the model and whether ﬁnite activity better describes jump activity than inﬁnite activity. In modeling
the jump process, we show that accounting for intraday periodicity changes the estimated frequency
and sizes of jumps within the day, as well as reducing the total number of estimated jumps per day. We
also evaluate and reject the hypothesis that microstructure noise dominates the test statistics, rendering
them uninformative.
We organize our paper as follows. Section 2 presents the methodology developed in A¨ıtSahalia and Jacod
(2012). Section 3 extends this technique to account for intraday periodicity. In Section 4, we describe the
exchange rate data and report our empirical results. Section 5 concludes and suggests some directions
for future research.
2. The base methodology
2.1. Theoretical background
In line with previous literature, we assume that the logprice X(t) follows a semimartingale such
that
dX(t) = µ(t)dt
. ¸¸ .
drift
+ σ(t)dW(t)
. ¸¸ .
continuous component
+ JUMPS(t), (1)
where dX(t) denotes the logarithmic price increment, µ(t) is a continuous, locally bounded, variation
process, σ(t) is a strictly positive and c`adl`ag (rightcontinuous with left limits) stochastic volatility
4
See Lustig and Verdelhan (2007) who present empirical evidence on the link between aggregate consumption growth
and exchange rate dynamics.
3
process, and W(t) is a standard Brownian motion. The JUMPS component of Model (1) potentially
represents both ﬁnite and inﬁniteactivity jumps. That is,
JUMPS(t) := κ(t)dq(t)
. ¸¸ .
ﬁnite activity
+ h(t)dL(t)
. ¸¸ .
inﬁnite activity
, (2)
where q(t) denotes a counting process (e.g. Poisson process), L(t) is a pure L´evy jump process (e.g.
a Cauchy process), and κ(t) and h(t) denote the jump sizes of the counting and L´evy processes, re
spectively. In the absence of the JUMPS component, Model (1) is known as Brownian SemiMartingale
(hereafter denoted BSM) model.
Assumptions and notation. We assume that the logprice process X(t) in (1) is observed at the discrete
points in time. The continuously compounded ith intraday return of a trading day t is given by
r
t,i
≡ X(t + i∆) − X(t + (i − 1)∆), with i = 1, ..., M and trading days t = 1, ..., T. Let M ≡ ⌊1/∆⌋
denote the number of intraday observations over the day; ∆ = 1/M is the time between consecutive
observations, the inverse of the observation frequency.
Some of our test statistics will be functions of “truncated power variations,” a class of statistics
depending on three parameters: p, the parameter for power variation, u, the truncation parameter, and
k, the sampling frequency parameter. We can now deﬁne the following realized measures introduced in
A¨ıtSahalia and Jacod (2010).
Deﬁnitions. Let
´
B(p, u, ∆)
t
be a truncated power variation computed at the ∆ frequency. That is,
´
B(p, u, ∆)
t
:=
1/∆
i=1
r
t,i

p
1
{r
t,i
≤u}
, (3)
where u = α∆
̟
is the threshold indexed by α (> 0) of standard deviations of the continuous part of the
process for a constant ̟ ∈ (0, 1/2). The truncation function on the righthand side of (3) can be used
to exclude large changes (i.e., jumps) from the calculation, which allows us to calculate moments from
the diﬀusion process in presence of jumps. Also note that
´
B(p, ∞, ∆)
t
is the nontruncated version of
(3), and therefore takes into account the contribution of jumps. It can be used to calculate moments
from the unconditional distribution. We can further consider the reverse version of (3), which can be
used to compute moments of large returns, excluding small returns.
5
That is,
´
U(p, u, ∆)
t
=
1/∆
i=1
r
t,i

p
1
{r
t,i
>u}
. (4)
To count the number of increments larger than u, we ﬁx p = 0, for example. Then, (4) becomes
´
U(0, u, ∆)
t
=
1/∆
i=1
1
{r
t,i
>u}
. (5)
In summary, we can use truncated power variation functions to compute statistics of diﬀusion returns
5
We distinguish jumps, which are detected by our jump tests, from large intraday returns, which might be informally
considered jumps.
4
and “large” returns. Armed with this theoretical setup, the next section presents the main hypotheses
and the corresponding testing procedures.
2.2. Hypotheses and test statistics
Throughout this section, we follow A¨ıtSahalia and Jacod (2012) and test four hypotheses:
(A) H
0
: Brownian motion is present vs. H
1
: Brownian motion is not present
(B) H
0
: Jumps are not present vs. H
1
: Jumps are present
(C) H
0
: Jumps have ﬁnite activity vs. H
1
: Jumps have inﬁnite activity
(D) H
0
: Jumps have inﬁnite activity vs. H
1
: Jumps have ﬁnite activity
In addition to those above, we further analyze i) how often jumps occur (i.e. degree of jump intensity
test), and check ii) whether market microstructure noise aﬀects the results (i.e. noise test). We test
these hypotheses by computing the following statistics and comparing them to their probability limits
under the various hypotheses.
 To test for the presence of Brownian motion:
´
S
W
(p, u, k, ∆)
t
=
´
B(p, u, ∆)
t
´
B(p, u, k∆)
t
P
−→
_
k
1−p/2
, X has Brownian motion on [0, t]
1, X has no Brownian motion on [0, t]
(6)
 To test for the presence of jumps of any types (ASJ test):
´
S
J
(p, k, ∆)
t
=
´
B(p, ∞, k∆)
t
´
B(p, ∞, ∆)
t
P
−→
_
1, X has jumps on [0, t]
k
p/2−1
, X is continuous on [0, t]
(7)
 To test the assumption that jumps have ﬁniteactivity:
´
S
FA
(p, u, k, ∆)
t
=
´
B(p, u, k∆)
t
´
B(p, u, ∆)
t
P
−→
_
k
p/2−1
, X has ﬁnitely many jumps on [0, t]
1, X has inﬁnitely many jumps on [0, t]
(8)
 To test the assumption that jumps have inﬁniteactivity:
´
S
IA
(p, p
′
, u, γ, ∆)
t
=
´
B(p
′
, γu, ∆)
t
´
B(p, u, ∆)
t
´
B(p
′
, u, ∆)
t
´
B(p
′
, γu, ∆)
t
P
−→
_
γ
p
′
−p
, X has inﬁnitely many jumps on [0, t]
1, X has ﬁnitely many jumps on [0, t]
(9)
where γ > 1, and p
′
is another parameter for power variation such that p
′
> p > 2.
The test statistics in (8) and (9) identify which types of jumps are likely to be present in the data
(ﬁnite or inﬁnite), but they are not informative about the degree of jump intensity. We thus estimate
the degree of activity of jumps with the BlumenthalGetoor index β.
6
The parameter β measures the
frequency of activity on a scale from 0 to 2. Activity that occurs ﬁnitely often—such as Poisson jumps—
has an activity level of β = 0. Activity that occurs inﬁnitely has a positive β.
7
For example, Cauchy
6
Other approaches to measure jump activity include the works of Todorov and Tauchen (2010), Belomestny (2010)
and Carr et al. (2002), among others.
7
Gamma process and VG process are exceptions.
5
and Normal Inverse Gaussian (NIG) jumps imply that β = 1, and Brownian motion is extremely active
with β = 2. We use two β estimators proposed by A¨ıtSahalia and Jacod (2009a). That is,
´
β(̟, α, α
′
, u, u
′
)
t
=
log(
´
U(0, u, ∆)
t
/
´
U(0, u
′
, ∆)
t
)
log(α
′
/α)
, (10)
where u
′
= α
′
∆
̟
is another truncation parameter for the ﬁxed values 0 < α < α
′
. Note that while (10)
is based on computing (5) evaluated at two truncation levels α and α
′
, the second estimator, given by
´
β
′
(̟, α, k, u)
t
=
log(
´
U(0, u, ∆)
t
/
´
U(0, u, k∆)
t
)
̟log k
, (11)
is based on sampling at two time scales ∆ and k∆ for k = 2.
The fact that the test statistics (6)−(8) have diﬀerent probability limits if microstructure noise
distorts them suﬃciently allows us to assess the importance of such noise for our hypothesis tests. If
the statistics in (6) to (8) converge to k, 1/k, and 1/k, respectively, then we conclude that such noise
renders these test statistics uninformative. That is,
 If market microstructure noise dominates, then the following are true:
´
S
W
P
−→k,
´
S
J
P
−→1/k,
´
S
FA
P
−→1/k. (12)
3. An extension: the role of intraday periodicity
The previous section presents the tools to choose the correct continuoustime model for exchange
rates. This section extends this base methodology to account for intraday periodicity. To do so, we
ﬁrst illustrate the presence of periodicity in the real intraday data, then we propose an appropriate
modiﬁcation of truncated power variation and the ASJ jump test statistic—in (7)—that corrects them
for the inﬂuence of intraday periodicity.
3.1. Motivation
Foreign exchange volatility shows strong intraday periodic eﬀects caused by regular trading patterns,
such as openings and closings of the three major markets, Asia, Europe and North America. Figure 1
displays distinct Ushaped patterns in the autocorrelation functions (ACFs) for the 1minute absolute
returns.
8
[ Insert Figure 1 about here ]
Figure 2 illustrates the periodicity by showing mean absolute EUR/USD, USD/JPY and GBP/USD
returns over the (1440) 1minute intervals.
[ Insert Figure 2 about here ]
The ﬁgure indicates that volatility is low during the Far East market hours, from 16:00 EST (21:00
GMT) to 24:00 EST (05:00 GMT) but activity picks up as Europe begins to trade around 2:00 EST
8
We describe the data in Section 4.1.
6
(7:00 GMT), and the Far Eastern market activity begins to wane. The most active period of the day is
during the overlap of the European and North American markets (between 7:00 EST and 11:00 EST).
Volatility starts to decline, as ﬁrst the European and then US, markets wind down. At around 16:00
EST (21:00 GMT), the Asian market reopens. This intraday pattern is consistent with those reported
in the literature.
9
Previous studies have shown that periodicity matters i) for estimating and forecasting intraday
volatility (e.g. Andersen and Bollerslev, 1998b), ii) for studying the impact of news on volatility (e.g.
Dominquez and Panthaki, 2006), iii) for estimating covolatility (Boudt et al., 2011a), and iv) for de
tecting intraday jumps (Boudt et al., 2011b). This paper shows that periodic volatility is also important
for continuoustime model selection problems.
3.2. The impact of periodicity on the realized power variation
The truncation parameter in the power variation statistics determines the cutoﬀ between diﬀusion
returns and “large” returns and so should depend on the conditional diﬀusion volatility. The test
statistics in (6)−(9) assume that the appropriate truncation threshold is constant over the trading
day, however. In this section, we show that ignoring intraday periodicity in volatility distorts the test
properties and we propose a correction. We carry out three Monte Carlo experiments. In Case I,
volatility is only stochastic, and there is no periodic component. In Case II, volatility is both stochastic
and periodic. We hold everything else (such as data generating process, parameter values, etc.) constant
to permit us to analyze the marginal impact of the periodic volatility. In Case III, we correct the testing
procedures to account for periodic volatility in the data generated by Case II. For brevity, we only report
the main results here, and Appendix A presents the details of the simulation setup.
Case I (no periodicity). In this case—in the absence of intraday periodicity, we count the number of
intraday returns larger than u = α∆
̟
(in 5) with ̟ = 0.47 and α = 2.
[ Insert Figure 3 about here ]
The upper panel of Figure 3 plots the total number of estimated large increments—per 1minute
interval—in the absence of periodicity. The ﬁgure delivers a clear message: as expected, in the absence
of jumps and with constant volatility, the number of observations discarded by the truncated power
variation with constant threshold is uniformly distributed over the day.
Case II (with periodicity). We add periodicity to the data generating process in Case I. The middle
panel of Figure 3 shows that truncated power variation discards too many “large” returns when periodic
volatility is high and too few when periodic volatility is low. That is, all of the estimated “large”
increments come from the high volatility portions of the day.
Case III (correction). To solve the problem highlighted in Case II, we replace the threshold u in (4)
and (5) by a timevarying threshold ¯ u that is proportional to the intraday periodicity in volatility f
t,i
,
i.e.
¯ u =
ˆ
f
WSD
t,i
α∆
̟
, (13)
9
See e.g. Andersen and Bollerslev (1998b).
7
where the parameters α, ∆ and ̟ are deﬁned as in Section 2.1. To estimate f
t,i
, we use the weighted
standard deviation (WSD), a robust to jumps estimator proposed by Boudt et al. (2011b) (see Appendix
B).
The lower panel of Figure 3 plots the total number of large increments retained by U(0, ¯ u, ∆)
t
.
Visual inspection suggests that the periodicityrobust threshold ¯ u works quite well: large increments
are uniformly distributed over the day, and U(0, ¯ u, ∆)
t
displays no cyclical patterns.
3.3. The impact of periodicity on the size of the ASJ jump test statistic
The experiments in the previous section show that periodic volatility changes the frequency and
distribution of the estimated large intraday returns. We suspect that such a change in the behavior of
large intraday returns may also aﬀect the size of the base jump test statistic
´
S
J
(p, k, ∆)
t
given in (7).
As before, we consider three simulation cases: nonperiodic DGP (Case I), periodic DGP (Case II), and
periodic DGP with correction stage (Case III).
Case I (no periodicity). To evaluate the level of the jump test, we follow A¨ıtSahalia and Jacod (2009b)
and ﬁrst standardize the statistic
´
S
J
(p, k, ∆)
t
by its (consistent) estimator for the asymptotic variance.
The standardized
´
S
J
(p, k, ∆)
t
is deﬁned as
´
S
J
(p, k, ∆)
t
−k
p/2−1
_
´
V
c
t
, (14)
where
´
V
c
t
is the estimator for the asymptotic variance of
´
S
J
(p, k, ∆)
t
, and it is based on the truncated
power variation
´
A(p, ∆). That is,
´
V
c
t
=
∆M(p, k)
´
A(2p, u, ∆)
t
´
A(p, u, ∆)
2
t
, (15)
where
´
A(p, u, ∆) :=
(1/M)
1−p/2
m
p
1/∆
i=1
r
t,i

p
1
{r
t,i
≤u}
, (16)
with
M(p, k) =
1
m
2
p
(k
p−2
(1 +k)m
2p
+k
p−2
(k −1)m
2
p
−2k
p/2−1
m
k,p
), (17)
where m
p
and m
k,p
are deﬁned as
m
p
= E(U
p
), (18)
m
k,p
= E(U
p
U +
√
k −1V 
p
), (19)
for U and V , two independent N(0, 1) variables. With the choice of p = 4, A¨ıtSahalia and Jacod
(2009b) show that M(4, k) = 16k(2k
2
−k −1)/3. That is, for k = 2, one gets M(4, 2) = 160/3. Under
the null of no jumps (i.e. Hypothesis (B)), the standardized test statistic in (14) is asymptotically (as
∆ →0) standard normal.
[ Insert Table 1 about here ]
8
Table 1 reports the probability of rejection of the ASJ jump test (via
´
S
J
) under the null hypothesis
of no jumps (i.e. Hypothesis (B)).
10
The table indicates that the rejection frequencies in simulations
are nearly correctly sized in the absence of periodicity in volatility, particularly at the higher sampling
frequencies (ﬁrst row − last three columns). The simulations support the asymptotic theory, with
rejection rates of 5.9%, 6.4% and 8.0% for the 30second, 1minute and 5minute data, respectively.
Case II (with periodicity). As shown in Section 3.1, the intraday volatility has a strong periodic com
ponent. Thus, we now turn to the case with periodic volatility (second row of Table 1) but a constant
threshold for large returns. Intraday periodicity signiﬁcantly increases the rejection rates of the base
jump test (9.2%, 9.5%, 10.7%, from high to low frequency). Nevertheless, periodic volatility tends to
have a little impact on the mean test statistics (middle three columns), which are still around the theo
retical predictions (i.e. 2). This suggests that periodicity mostly aﬀects the variance of the standardized
test statistic.
Case III (correction). To account for intraday periodicity, we ﬁrst estimate the periodic component of
volatility by
ˆ
f
WSD
t,i
(see Appendix B), and next replace the base threshold u in (16) by a periodicity
robust threshold ¯ u in (13). Our twostage correction method for intraday volatility patterns reduces
overrejection at all sampling frequencies, but more so at the highest frequencies, 30seconds and 1
minute (7.3% and 8.0%, respectively).
11
4. Empirical application
This section describes the data, and reports the results of our empirical analysis.
12
Throughout, we
correct the test statistics and estimators (i.e. (6) to (11)) for the presence of intraday periodicity and
thus use the robust threshold ¯ u rather than u.
4.1. Data
We use 1minute data for the EUR/USD, USD/JPY and GBP/USD exchange rates over a period
from January 1, 2000 to March 12, 2010. Disk Trading provides the last midquotes (average of the
logarithms of bid and ask quotes) of 1minute intervals throughout the global 24hour trading day.
Following Andersen and Bollerslev (1998a), one trading day extends from 16:01 EST on day t − 1 to
16:00 EST on day t.
As is usual in the literature, we omit trading days with too many missing values or low trading
activity because they will provide poor estimates of volatility. Similarly, we deleted weekends plus
certain ﬁxed and irregular holidays, trading days for which there are more than 360 missing values at
the 1minute frequency (corresponding to more than one fourth of the data), and trading days with
10
Following A¨ıtSahalia and Jacod (2009b), we compute
S
J
for each trading day, consisting of 24 hours of foreign
exchange activity.
11
For brevity, we only report the simulation results under constant volatility model but a stochastic volatility structure
(e.g. GARCHtype) does not change the results.
12
Before applying the aforementioned tests to real data, we assessed the properties of the tests on simulated data with
appropriate parameter values (e.g. p, u, k) and cutoﬀ levels (e.g. α, ̟) to ensure that they provide the expected behavior
for realistic sample sizes. Monte Carlo results indicate that all testing procedures perform quite well. For brevity, we do
not report these ﬁndings but they are available upon request.
9
too many empty intervals and consecutive prices.
13
These criteria leave 2483, 2479 and 2472 days,
respectively, for the EUR/USD, USD/JPY and the GBP/USD exchange rates.
4.2. Results
4.2.1. Brownian motion: present or not
The ﬁrst question that we ask is the following: Does an appropriate model of high frequency exchange
rates need Brownian motion? To answer this question, we compute the nonstandardized test statistic
´
S
W
(p, ¯ u, k, ∆)
t
in (6) for each day in the sample. Figure 4 plots the histogram of these daily statistics
for the EUR/USD, USD/JPY and GBP/USD exchange rates.
[ Insert Figure 4 about here ]
The ﬁgure clearly shows that Brownian motion is present in the data. Under the null hypothesis
that the Brownian motion is present (i.e. Hypothesis (A)), we expect the theoretical distribution
of
´
S
W
(p, ¯ u, k, ∆)
t
to be dispersed around k
1−p/2
, that is 1.4142 and 1.7321 with (p = 1, k = 2)
and (p = 1, k = 3), respectively. For all exchange rates, the empirical distribution of the non
standardized
´
S
W
(p, ¯ u, k, ∆)
t
is around 1.5 (k = 2) and 1.9 (k = 3)—well above the limit under the
alternative (i.e. 1), indicating that Brownian motion is present in the data. This conﬁrms the results
of Todorov and Tauchen (2010) and Cont and Mancini (2011).
4.2.2. Jumps: present or not
Are jumps present in the exchange rate data? Table 2 reports the results of the A¨ıtSahalia and Jacod
(2009b) jump test—based on (7)—applied to EUR/USD, USD/JPY and GBP/USD rates for various
truncation and scaling parameters (̟ = 0.47, 0.48 and k = 2, 3).
[ Insert Table 2 about here ]
The table shows that the jump test in (7) rejects the null of no jumps (i.e. Hypothesis (B)). For
example, the top row of the table shows that the test detects 162 jumps for the parameters ̟ = 0.47
and k = 2, at the 5% level. With the same truncation parameter—that is ̟ = 0.47—but with higher
scaling (k = 3), the test detects fewer jumps, only 129 for the EUR/USD.
[ Insert Figure 5 about here ]
Figure 5 displays the empirical distributions of the nonstandardized (upper panels) and standardized
(lower panels) test statistic
´
S
J
(p, k, ∆)
t
, computed on the EUR/USD, USD/JPY and GBP/USD data.
For brevity, we plot the histograms only for k = 2. Recall that the empirical densities should be
around 2 under the null hypothesis of no jumps (see Equation (7)). The ﬁgure shows that this is not
the case in the real data. Instead, the values of
´
S
J
(p, k, ∆)
t
are around 1, indicating the presence of
jumps (upper panels). We also observe that the empirical density of the standardized test statistic
(lower panels) signiﬁcantly departs from the N(0, 1) density which is the expected density only in the
absence of jumps. That is, the empirical density appears to be skewed and kurtotic. Overall, the
A¨ıtSahalia and Jacod (2009b) jump test indicates that EUR/USD, USD/JPY and GBP/USD returns
contain jumps at the 1minute sampling frequency during the 2000 through 2010 sample.
13
These holidays include New Year (December 31  January 2), Martin Luther King Day, Washington’s Birthday or
Presidents’ Day, Good Friday, Easter Monday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day and
Christmas (December 24  26).
10
4.2.3. Jumps: ﬁnite or inﬁnite activity
Do exchange rate jumps exhibit ﬁnite or inﬁniteactivity? We ﬁrst focus on the ﬁnite activity test
(i.e. Hypothesis (C)), and set k = 2 and p = 4 to compute (8). Recall that, for these parameter choices,
we expect the test statistic to be distributed around 2, if jumps have ﬁniteactivity, and 1 otherwise.
[ Insert Figure 6 about here ]
Figure 6 displays the empirical distribution of
´
S
FA
(p, ¯ u, k, ∆)
t
for parameters α = 6 (left panels)
and α = 10 (right panels). For all exchange rate data, the histograms in the ﬁgure show that the means
of the distributions of
´
S
FA
(p, ¯ u, k, ∆)
t
range from about 1.4 to 1.7, that is, they are between 1 and
2, which are the theoretical limits under the alternative of inﬁnite activity and null of ﬁnite activity,
respectively. The ﬁgure further reports the mean of
´
S
FA
(p, ¯ u, k, ∆)
t
for α = 6, 10—that is low α and
high α—as in A¨ıtSahalia and Jacod (2011). The means are about 1.55 (left panels) and 1.65 (right
panels) for the EUR/USD, USD/JPY and GBP/USD series. These are well above 1, which is the
probability limit in the inﬁniteactivity case.
As an alternative to the ﬁnite activity test—via
´
S
FA
(p, ¯ u, k, ∆)
t
, we now consider a null hypothesis
that jumps have inﬁnite activity (i.e. Hypothesis (D)). In this case, under the null hypothesis of inﬁnite
jump activity, the test statistic,
´
S
IA
(p, p
′
, ¯ u, γ, ∆)
t
, should be close to 2 (for γ = 2, p
′
= 4, p = 3).
We reject the null hypothesis of inﬁnite activity jumps if
´
S
IA
(p, p
′
, ¯ u, γ, ∆)
t
is around 1 (see Equation
(9)). Table 3 reports the empirical means of both test statistics applied to EUR/USD, USD/JPY and
GBP/USD returns.
[ Insert Table 3 about here ]
The lower panel of Table 3 shows that the test in (9) rejects the null hypothesis of inﬁnite jump
activity. That is, although the empirical mean of
´
S
FA
(p, ¯ u, k, ∆)
t
is around 1.60 (upper panel),
´
S
IA
(p, p
′
, ¯ u, γ, ∆)
t
is close to 1 for all series (lower panel). We therefore conclude that while the ﬁrst
test (via
´
S
FA
(p, ¯ u, k, ∆)
t
) accepts the null of ﬁnite activity for high α values, the second test (via
´
S
IA
(p, p
′
, ¯ u, γ, ∆)
t
) rejects the null hypothesis that jumps have inﬁnite activity. Thus, we conclude
that 1minute data tend to be more compatible with ﬁnite jump activity, in line with the results of
A¨ıtSahalia and Jacod (2011).
4.2.4. How active are exchange rate jumps?
The empirical results—reported in Sections 4.2.2 and 4.2.3—indicate that ﬁnite activity jumps are
present in the exchange rate data. We now analyze the degree of activity of exchange rate jumps, and
ask which jump process is likely to better capture those jumps.
[ Insert Table 4 about here ]
Table 4 reports the estimates of the jump activity index β for the EUR/USD, USD/JPY and
GBP/USD returns. Recall that ﬁnite activity jumps—such as Poisson jumps—have an activity level of
β = 0 while inﬁnite activity jumps have positive βs. To be consistent with our (unreported) simulation
study, we choose the cutoﬀ levels ̟ = 0.47 (left panels) and ̟ = 0.40 (right panels).
14
We further
14
These simulation results are available upon request.
11
consider various levels of α ranging from 6 to 10 standard deviations of the continuous part of the
process. Table 4 conﬁrms that 1minute exchange rate data display ﬁnite jump activity.
´
β
′
(̟, α, k, ¯ u)
t
and
´
β(̟, α, α
′
, ¯ u, ¯ u
′
)
t
, in (11) and (10), range from 0.07 to 0.10—for α = 6, indicating a low degree of
jump activity, consistent with a compound Poisson process. The standard errors of these estimates are
much larger than the estimates themselves, indicating that we cannot reject the null that they are zero.
Table 4 further shows that increasing α (from 6 to 10) moves the index estimates closer to 0,
producing more evidence for large and infrequent jumps, and reduces standard errors. This is expected
because higher α gives a larger truncation level ¯ u =
ˆ
f
WSD
t,i
α∆
̟
, which allows us to retain relatively
more (small) jumps for computing power variations, leaving larger increments. These results hold for
all exchange rate series.
[ Insert Figure 7 about here ]
To summarize our results, Figure 7 shows the spectrum of the EUR/USD returns, and displays
the three possible limits of the test statistics: i) under the null hypothesis, ii) under the alternative
hypothesis, iii) when market microstructure noise dominates. In line with our previous discussions,
we reject the null of no Brownian motion (top panel), we reject the null of no jumps (middle panel),
and ﬁnd evidence in favor of ﬁnite activity jumps (lower panel). For all testing procedures, the ﬁgure
indicates that microstructure noise does not dominate the results.
15
4.2.5. The relative magnitude of the components
We can also disentangle the quadratic variation (QV ) of the exchange rate process into its continuous
and jump components. That is,
Components
_
¸
¸
¸
_
¸
¸
¸
_
B(p, u,∆)
t
B(p,∞,∆)
t
⇒ %QV due to the continuous component
U(p,ǫ,∆)
t
B(p,∞,∆)
t
⇒ %QV due to big jumps
B(p,∞,∆)
t
−
B(p, u,∆)
t
−
U(p,ǫ,∆)
t
B(p,∞,∆)
t
⇒ %QV due to small jumps
(20)
where QV is the sum of the integrated variance and the cumulative squared jumps.
16
In (20), the
function
´
B denotes truncated power variation; it estimates moments of the diﬀusion process. In contrast,
the function
´
U is reverse truncated power variation; it estimates moments of the jump process. Also
note that while (6) requires a power p < 2, the test statistic in (7) identiﬁes the presence of jumps for
p > 2. To split the QV into its components, we need to ﬁx p = 2 so that all components are present
together. The jump size cutoﬀ parameter ǫ in (20) distinguishes big and small jumps. Larger values of
ǫ will mean that a given return will have to be larger to count as a “big” jump. That is, other things
equal, a larger value of ǫ will attribute more variation to small jumps and less to “big” jumps because
it will pick out fewer “big” jumps.
15
The spectrographic analyses of the USD/JPY and GBP/USD returns are quite similar, and hence we do not show
the results here in order to save space.
16
The drift term (e.g. µ(t) in (1)) does not aﬀect QV ; Andersen and Benzoni (2008) discuss this issue. Further,
the integrated variance, the variance of the continuous component, of the underlying logprice process in Model (1)
can be further deﬁned as IV
t
≡
t
t−1
σ
2
(s)ds, which is latent because σ
2
(s) is not directly observable. An unbiased
estimation of IV
t
depends on whether the jump component of the logprice process has ﬁnite or inﬁniteactivity. See
BarndorﬀNielsen and Shephard (2004), Mancini (2009) and Bollerslev and Todorov (2011a) who present alternative es
timators for IV
t
.
12
[ Insert Table 5 about here ]
Tables 5 reports the percentages of total quadratic variation (QV ) due to each component of the
EUR/USD, USD/JPY and GBP/USD exchange rates. The table indicates that Brownian motion
(QV
Brownian
) drives around 85% of QV for all exchange rates. Jumps represent about 15% of QV (i.e.
QV
big jumps
+ QV
small jumps
). For the cutoﬀ level ǫ = 0.09, big jumps comprise approximately 10−14%
of QV . Raising the cutoﬀ level, ǫ, from 0.09 to 0.19, increases the proportion of small jumps in the
quadratic variation and reduces the proportion of QV that big jumps explain.
17
[ Insert Figure 8 about here ]
Figure 8 plots the fraction of QV attributable to the continuous and jump components of EUR/USD
rate and for every trading day in our sample. The ﬁgures show that %QV of both Brownian and jump
components tend to be rather stable over time (ﬁrst and second panels). Although the proportion of
QV due to big jumps increases following the collapse of Lehman Brothers (September 15, 2008), the
QV components appear to be fairly stable during the ﬁnancial crisis.
18
4.2.6. Intraday periodicity and jump detection
In Section 3.3, the simulation evidence reveals that the ASJ jump test tends to overreject in the
presence of periodicity. We now apply the basic and periodicityrobust ASJ jump tests to real data.
Table 6 reports the results of the ASJ test when we ignore periodicity (row “No”), and when we account
for it (row “WSD”).
[ Insert Table 6 about here ]
The table shows that the periodicityrobust ASJ test always identiﬁes fewer jumps than the basic test.
For instance, at the 10% signiﬁcance level (column j = 0.10) and for ̟ = 0.47, the basic test—i.e., no
correction for periodicity in volatility—detects 189 daily EUR/USD jumps whereas the corrected tests
identify 156 jumps.
[ Insert Figure 9 about here ]
Furthermore, the left panels of Figure 9 plot the total number of large exchange rate returns per (1
minute) intraday period that are retained by (5)’s indicator function. Without a correction for intraday
patterns in volatility, most of the estimated large increments occur during the high volatility periods
when European and North American markets are open.
We repeat the same exercise but now correct for intraday volatility patterns by replacing (5) by its
periodicityrobust version. The right panels of Figure 9 illustrate that the patterns change signiﬁcantly,
and cyclicality largely disappears. That is, we obtain more uniform occurrence of large returns when
we estimate periodicity by WSD and permit truncation levels to vary with these periodicity estimates.
17
In unreported simulation results, we tested whether the base ratio
B(p,u,∆)
t
B(p,∞,∆)
t
in (20) is around 1 under the null
hypothesis of no jumps. At the 1minute sampling frequency, we found that Monte Carlo mean values are indeed around
0.99 when we choose the truncation levels ̟ = 0.47 and α = 3. For lower truncation values such as α = 2, the ratio
becomes 0.89, and hence it tends to underestimate the proportion of QV due to the continuous component. The volatility
process (constant or GARCH) does not aﬀect these simulation results. We thus set ̟ = 0.47 and α = 3 when applying
the QV statistic to the real exchange rate data. These results are available upon request.
18
The results are similar for other exchange rates and thus we do not report them to save space. Further, we do not
speciﬁcally study here how crisis periods aﬀect the spectrum analysis. Recently, Dungey et al. (2011) propose alternative
test statistics doing this job by discriminating good and bad market times.
13
5. Conclusion
This paper shows that exchange rate variation over short time scales is mostly Browniandriven
(85%) but that jumps contribute a substantial proportion of the variation, 15%. Using a variety of
statistics based on power variation, we ﬁnd that foreign exchange jumps have ﬁnite activity, and a
compound Poisson process is a good candidate to capture exchange rate jumps. We also demonstrate
that the diﬀusion and jump tests have good properties in 1minute data, even in the presence of
microstructure noise.
Failing to account for periodic volatility has two important eﬀects: First, truncated power variation
identiﬁes too many (few) large intraday returns during periods of high (low) volatility. Second, the
jump test detects too many jumps, unconditionally. We propose a correction procedure that ﬁlters out
these timeofday eﬀects from the highfrequency data.
Further research can explore at least two issues. First, one can use the test of A¨ıtSahalia et al.
(2012) to detect jumps at very high frequencies (such as 5second) when market microstructure noise
dominates at those frequencies. Second, following Dungey et al. (2011), a study of the diﬀerential
behavior of exchange rate volatility and jumps during crises and normal times is very likely to provide
new perspectives on this topic.
Acknowledgments
We thank Mardi Dungey, Marius Matei, Jean Jacod, Michel van der Wel, and participants at the third
HumboldtCopenhagen Financial Econometrics Conference, Universit´e Catholique de Louvain CESAM
seminar, Bogazici University Annual CEE Conference, and I
´
ESEG School of Management Finance
Seminar for valuable comments and helpful suggestions.
14
Appendix A. Monte Carlo study of the periodicity analysis
Case I. We consider three sampling frequencies: 30seconds (i.e. M = 2880), 1minute (i.e. M = 1440),
and 5minutes (i.e. M = 288). We set T = 250, and the number of replications is 1000. The DGP is a
BSM diﬀusion model with constant volatility:
dX(t) = σ(t)dW(t) (21)
σ(t) = σ
constant
=
√
0.30 (22)
Cases II and III. While the simulation setup of Case I remains same, we now specify σ(t) as a multi
plicative process of the periodicity function f(τ(t)), a ﬂexible Fourier form (FFF), which depends only
on the time of the day τ(t), and a constant volatility process:
dX(t) = σ(t)dW(t) (23)
σ(t) = f(τ(t))σ
constant
(24)
σ
constant
=
√
0.30 (25)
log f(τ(t)) =
4
j=1
(γ
j
cos(2τ(t)jπ) +δ
j
sin(2τ(t)jπ)) (26)
where the cos and sin terms depend on the time of the day and we use the following estimated param
eters:
(γ
1
, δ
1
, . . . , γ
4
, δ
4
) = (−0.24422, −0.49756, −0.054171, 0.073907,
−0.26098, 0.32408, −0.11591, −0.21442).
Remark. We repeat the simulation exercises above by using a stochastic volatility structure (i.e. GARCH
type diﬀusion process). The results do not change and thus—for brevity—we do not report those ﬁndings
in the main text.
Appendix B. Volatility dynamics and periodicity estimation
Let us consider a Brownian model (BSM) without any JUMPS component but with intraday periodicity
in volatility. If ∆ is suﬃciently small, then returns are conditionally normally distributed with mean
zero and variance equal to the integral of underlying volatility over the short interval.
σ
2
t,i
=
_
t+i∆
t+(i−1)∆
σ
2
(s)ds, (27)
that is r
t,i
≈ σ
t,i
z
t,i
, where z
t,i
∼ N(0, 1). We assume that the highfrequency return variance σ
2
t,i
in
(27) has a periodic component f
2
t,i
which represents the intraday periodic features.That is,
σ
t,i
= s
t,i
f
t,i
, (28)
where s
t,i
is the stochastic intradaily volatility, constant over the day but varying from one day to
another.
19
The periodic factor f
t,i
is a deterministic function of time within a day. One can estimate
s
t,i
using the square root of the realized volatility on day t by setting p = 2, u = ∞ and k = 1 in (3).
That is,
ˆ s
t,i
=
_
1
M
´
B(2, ∞, ∆)
t
. (29)
19
See e.g. Andersen and Bollerslev (1998a), Hecq et al. (2011), and Visser (2010) who also assume that s
t,i
is constant
over the day but can vary from day to another.
15
In the presence of jumps (e.g. BSMFAJ model), the square root of BarndorﬀNielsen and Shephard
(2004)’s bipower variation estimates the diﬀusion variance, s
t,i
, better than (29). That estimator is
ˆ s
t,i
=
_
1
M −1
BV
t
, (30)
where
BV
t
≡ µ
−2
1
M
(M −1)
M
i=2
r
t,i
r
t,i−1
, (31)
where µ
1
≡
_
2/π ≃ 0.79788. Under this representation, the standardized highfrequency return
r
t,i
= r
t,i
/ˆ s
t,i
∼ N(0, f
2
t,i
) as ∆ →0. This result suggests estimating the periodicity factor f
t,i
in (28)
using an estimator of the scale of the standardized returns. That is,
r
t,i
=
r
t,i
√
BV
t
, (32)
where BV
t
is given in (31). Boudt et al. (2011b) recommend the use of the Shortest Half scale
estimator—proposed by Rousseeuw and Leroy (1988), because this estimator remains consistent in the
presence of inﬁnitesimal contaminations by jumps in the data. To deﬁne the Shortest Half scale estima
tor, we denote the corresponding order statistics r
(1);t,i
, . . . , r
(n
t,i
);t,i
such that r
(1);t,i
≤ r
(2);t,i
≤ . . . ≤
r
(n
t,i
);t,i
. The shortest half scale is the smallest length of all “halves” consisting of h
t,i
= ⌊n
t,i
/2⌋+1 con
tiguous order observations. These halves equal {r
(1);t,i
, . . . , r
(h
t,i
);t,i
}, . . ., {r
(n
t,i
−h
t,i
+1);t,i
, . . . , r
(n
t,i
);t,i
},
and their length is r
(h
t,i
);t,i
−r
(1);t,i
, . . ., r
(n
t,i
);t,i
−r
(h
t,i
);t,i
, respectively. The corresponding scale es
timator (corrected for consistency under normality) equals the minimum of these lengths:
ShortH
t,i
= 0.741 · min{r
(h
t,i
);t,i
−r
(1);t,i
, . . . , r
(n
t,i
);t,i
−r
(n
t,i
−h
t,i
+1);t,i
}. (33)
The Shortest Half estimator for the periodicity factor of r
t,i
equals
ˆ
f
ShortH
t,i
=
ShortH
t,i
_
1
M
M
j=1
ShortH
2
t,j
. (34)
The shortest half dispersion is highly robust to jumps, but it has only a 37% relative eﬃciency under
normality of the r
t,i
’s. Boudt et al. (2011b) show that the standard deviation applied to the returns
weighted by their outlyingness under the ShortH estimate oﬀers a better tradeoﬀ between the eﬃciency
of the standard deviation under normality and robustness to jumps. That is,
ˆ
f
WSD
t,i
=
WSD
t,i
_
1
M
M
j=1
WSD
2
t,j
, (35)
where
WSD
t,j
=
¸
¸
¸
_
1.081 ·
n
t,j
l=1
w[(r
l;t,j
/
ˆ
f
ShortH
t,j
)
2
]r
2
l;t,j
n
t,j
l=1
w[(r
l;t,j
/
ˆ
f
ShortH
t,j
)
2
]
. (36)
Because the weighting is applied to the squared standardized returns, which are extremely large in
the presence of jumps, Boudt et al. (2011b) recommend the use of the hard rejection with threshold
equal to the 99% quantile of the χ
2
distribution with one degree of freedom, that is
w(z) =
_
1 if z ≤ 6.635
0 else.
(37)
The factor 1.081 in Equation (36) further ensures the consistency of the estimator under normality.
The Weighted Standard Deviation (WSD) in (35) has a 69% eﬃciency under normality of the r
t,i
’s.
16
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19
Table 1: The impact of periodicity on the actual size of the jump test at the 5% level
Panel A. Constant Volatility Model
Periodicity? Correction? Mean
´
S
J
(p, k, ∆)
t
Rejection rates
30sec 1min 5min 30sec 1min 5min
Case I No No 2.0006 2.0015 2.0082 5.9% 6.4% 8.0%
Case II Yes No 2.0035 2.0047 2.0194 9.2% 9.5% 10.7%
Case III Yes Yes 2.0035 2.0047 2.0194 7.3% 8.0% 10.0%
Notes: The table shows the size of the ASJ jump test under the null hypothesis of no jumps under three
cases, described in the text. The mean
´
S
J
(p, k, ∆)
t
statistic (see Equation (7)) should converge in probability
to 2. We estimate periodic component f
t,i
using WSD.
Table 2: Testing the presence of jumps in the exchange rate data
Mean
´
S
J
(p, k, ∆)
t
Detected daily jumps
EUR/USD
̟ k Asymptotic Empirical j = 0.10 j = 0.05 j = 0.01
0.47 2 2 1.4533 189 162 112
0.47 3 3 1.9479 149 129 96
0.48 2 2 1.4533 198 169 119
0.48 3 3 1.9479 156 134 104
USD/JPY
̟ k Asymptotic Empirical j = 0.10 j = 0.05 j = 0.01
0.47 2 2 1.3036 136 101 75
0.47 3 3 1.6304 94 85 61
0.48 2 2 1.3036 144 113 78
0.48 3 3 1.6304 103 89 68
GBP/USD
̟ k Asymptotic Empirical j = 0.10 j = 0.05 j = 0.01
0.47 2 2 1.4446 170 146 103
0.47 3 3 1.8762 126 98 71
0.48 2 2 1.4446 182 154 116
0.48 3 3 1.8762 135 109 73
Notes: The table shows the results of the A¨ıtSahalia and Jacod
(2009b) jump test. The column labeled “Asymptotic” presents asymp
totic probability limits under the null hypothesis of no jumps. The
sample covers the periods from January 1, 2000 to March 12, 2010.
The sampling frequency is 1minute. The table reports the number of
detected daily jumps. j denotes the signiﬁcance levels of the test. We
set α = 4 and p = 4.
20
Table 3: Testing whether exchange rate jumps have ﬁnite or inﬁnite activity
´
S
FA
(p, ¯ u, k, ∆)
t
Asymptotic Empirical
α = 6 α = 7 α = 8 α = 9 α = 10
EUR/USD 2 1.6237 1.6314 1.6877 1.6430 1.7029
USD/JPY 2 1.4429 1.4733 1.5225 1.5405 1.5610
GBP/USD 2 1.5869 1.6128 1.6623 1.6829 1.7407
´
S
IA
(p, p
′
, ¯ u, γ, ∆)
t
EUR/USD 2 1.2093 1.1718 1.1553 1.1326 1.1191
USD/JPY 2 1.2002 1.1954 1.1820 1.1726 1.1543
GBP/USD 2 1.1853 1.1506 1.1297 1.1172 1.1023
Notes: The table presents the empirical mean values of the ﬁnite activity
test statistic
´
S
FA
(p, ¯ u, k, ∆)
t
(upper panel) and inﬁnite activity test statistic
´
S
IA
(p, p
′
, ¯ u, γ, ∆)
t
(lower panel). The sample covers the periods from Jan
uary 1, 2000 to March 12, 2010. The sampling frequency is 1minute. For
´
S
FA
(p, ¯ u, k, ∆)
t
, we set p = 4. For
´
S
IA
(p, p
′
, ¯ u, γ, ∆)
t
, we set p
′
= 4, p = 3,
and γ = α
′
/α = 2. For both tests, we choose ̟ = 0.47, and k = 2. The col
umn labeled “Asymptotic” presents asymptotic probability limits under the
respective null hypotheses. In the top panel, the null is ﬁnite jumps and the
alternative is inﬁnite jumps. In the bottom panel, the null is inﬁnite jumps
and the alternative is ﬁnite jumps.
Table 4: Estimates of jump activity levels from exchange rate returns
´
β
′
(̟, α, k, ¯ u)
t
̟ = 0.47 ̟ = 0.40
α = 6 α = 8 α = 10 α = 6 α = 8 α = 10
EUR/USD 0.103 0.015 0.006 0.007 0.002 0.000
(0.534) (0.223) (0.138) (0.170) (0.071) (0.000)
USD/JPY 0.103 0.031 0.010 0.013 0.004 0.001
(0.525) (0.312) (0.160) (0.186) (0.100) (0.050)
GBP/USD 0.089 0.017 0.006 0.005 0.003 0.001
(0.527) (0.211) (0.117) (0.105) (0.112) (0.050)
´
β(̟, α, α
′
, ¯ u, ¯ u
′
)
t
EUR/USD 0.074 0.013 0.006 0.006 0.001 0.000
(0.394) (0.161) (0.106) (0.106) (0.048) (0.000)
USD/JPY 0.075 0.019 0.008 0.008 0.002 0.000
(0.391) (0.187) (0.131) (0.131) (0.059) (0.000)
GBP/USD 0.069 0.010 0.003 0.003 0.001 0.001
(0.387) (0.132) (0.081) (0.081) (0.049) (0.034)
Notes: The table displays the estimates of
´
β
′
(̟, α, k, ¯ u)
t
(upper panel) and
´
β(̟, α, α
′
, ¯ u, ¯ u
′
)
t
(lower panel) for the EUR/USD, USD/JPY and GBP/USD
exchange rates. The sample covers the periods from January 1, 2000 to March
12, 2010. We choose k = 2, α
′
/α = 1.5, and ﬁx p = 0. Standard deviations of
the estimators are reported in parenthesis. For ﬁnite activity processes, the test
statistics should converge in probability to zero.
21
Table 5: Quadratic variation (QV ) for the EUR/USD, USD/JPY and GBP/USD
Jump size cutoﬀ
EUR/USD ǫ = 0.09 ǫ = 0.13 ǫ = 0.19
QV
Brownian
86.47% 86.47% 86.47%
QV
big jumps
12.25% 6.46% 3.62%
QV
small jumps
1.28% 7.07% 9.92%
USD/JPY
QV
Brownian
85.68% 85.68% 85.68%
QV
big jumps
14.08% 7.45% 4.09%
QV
small jumps
0.24% 6.87% 10.23%
GBP/USD
QV
Brownian
85.71% 85.71% 85.71%
QV
big jumps
10.22% 5.27% 2.89%
QV
small jumps
4.07% 9.02% 11.41%
Notes: The table shows the fraction of quadratic
variation (QV ) attributable to the continuous and
jump components for the exchange rates. The
sample covers the periods from January 1, 2000
to March 12, 2010. We ﬁx p = 2, α = 3 and ̟ =
0.47. The truncation rate is ¯ u =
ˆ
f
WSD
t,i
α
√
BV
t
∆
̟
.
Table 6: Testing for jumps when volatility is periodic
Correction? EUR/USD USD/JPY GBP/USD
j = 0.10 j = 0.05 j = 0.05 j = 0.10 j = 0.05 j = 0.05 j = 0.10 j = 0.05 j = 0.05
̟ = 0.47 No 189 162 112 136 101 75 170 146 103
[0.08] [0.07] [0.05] [0.05] [0.04] [0.03] [0.07] [0.06] [0.04]
WSD 156 125 82 115 91 66 141 116 74
[0.06] [0.05] [0.03] [0.05] [0.04] [0.03] [0.06] [0.05] [0.03]
̟ = 0.48 No 198 169 119 144 113 78 182 154 116
[0.08] [0.07] [0.05] [0.06] [0.05] [0.03] [0.07] [0.06] [0.05]
WSD 169 136 91 124 96 69 150 130 81
[0.07] [0.05] [0.04] [0.05] [0.04] [0.03] [0.06] [0.05] [0.03]
Notes: The table shows the results of the base and periodicityrobust A¨ıtSahalia and Jacod (2009b) jump
tests. We use nonparametric WSD method to estimate periodicity and correct the test. The table reports
the number of detected daily jumps and the jump proportion in brackets (100×#jumps/#days). j denotes
the signiﬁcance levels of the test. We report the results for k = 2. The sample period and other parameter
values are same as in Table 2 (i.e. α = 4 and p = 4).
22
ACFAbsolute 1min returns (EUR/USD)
0 1450 2900 4350 5800
0.5
1.0
(a) EUR/USD
ACFAbsolute 1min returns (EUR/USD) ACFAbsolute 1min returns (USD/JPY)
0 1450 2900 4350 5800
0.5
1.0
(b) USD/JPY
ACFAbsolute 1min returns (USD/JPY) ACFAbsolute 1min returns (GBP/USD)
0 1450 2900 4350 5800
0.5
1.0
(c) GBP/USD
ACFAbsolute 1min returns (GBP/USD)
Figure 1: ACF of the absolute EUR/USD, USD/JPY and GBP/USD returns at 1minute sampling frequency. The
number of lags corresponds to 5 days of 1minute observations.
All Days
0 300 600 900 1200
0
.
0
1
0
.
0
2
0
.
0
3
0
.
0
4
0
.
0
5
(a) EUR/USD
intraday periods
Far East opens
Europe opens
N. America opens
Europe
closes
All Days All Days
0 300 600 900 1200
0
.
0
1
0
.
0
2
0
.
0
3
0
.
0
4
0
.
0
5
(b) USD/JPY
intraday periods
Far East opens
Europe opens
N. America opens
Europe
closes
All Days
All Days
0 300 600 900 1200
0
.
0
1
0
.
0
2
0
.
0
3
0
.
0
4
0
.
0
5
(c) GBP/USD
intraday periods
Far East opens
Europe opens
N. America opens
Europe
closes
All Days
Figure 2: Mean absolute 1min EUR/USD (left), USD/JPY (middle) and GBP/USD (right) returns on whole sample.
The Xaxis represents the intraday periods in EST, from 16:01 EST of day t − 1 to 16:00 EST of day t.
23
total number of large increments per intraday period (no periodicity)
0 150 300 450 600 750 900 1050 1200 1350
2.5
5.0
7.5
total number of large increments per intraday period (no periodicity)
total number of large increments per intraday period (with periodicity)
0 150 300 450 600 750 900 1050 1200 1350
1000
2000
3000 total number of large increments per intraday period (with periodicity)
total number of large increments per intraday period (WSD correction)
0 150 300 450 600 750 900 1050 1200 1350
2.5
5.0
7.5
total number of large increments per intraday period (WSD correction)
Figure 3: The number of estimated large increments retained by 1{} per intraday period (see Equation (5)). The number
of simulations is 1000 with T = 250 and M = 1440 (i.e. 1minute sampling frequency). The data generating process
generates jumps uniformly throughout the day. In the upper and middle panels, the truncation rate is u = α∆
̟
. In the
lower panel, the truncation rate is u =
ˆ
f
t,i
α∆
̟
. We set ̟ = 0.47 and α = 2. The details of the simulation study are
available upon request.
1.2 1.4 1.6 1.8 2.0 2.2
2
4
EUR/USD (k=2)
Brownian Motion: Present or Not?
mean S
W
=1.5670
1.5 2.0 2.5 3.0
1
2
EUR/USD (k=3)
mean S
W
=1.9977
1.2 1.4 1.6 1.8 2.0 2.2
2
4
USD/JPY (k=2)
mean S
W
=1.5805
1.5 2.0 2.5 3.0
1
2
USD/JPY (k=3)
mean S
W
=2.0301
1.2 1.4 1.6 1.8 2.0 2.2
2
4
GBP/USD (k=2)
mean S
W
=1.5447
1.5 2.0 2.5 3.0
1
2
GBP/USD (k=3)
mean S
W
=1.9625
Figure 4: Empirical distribution of the nonstandardized test statistic
S
W
(p, u, k, ∆)
t
in Equation (6) for k = 2 (left
panels) and k = 3 (right panels). The sample covers the periods from January 1, 2000 to March 12, 2010. We set p = 1
and α = 8. The sampling frequency is 1minute. Under the null that Brownian motion is present in the data, the test
statistic in the left (right) hand panels should converge in probability to k
1−p/2
.
24
0 1 2 3 4 5
0.25
0.50
0.75
1.00
EUR/USD (k=2)
0 1 2 3 4 5
0.25
0.50
0.75
1.00
USD/JPY (k=2)
Jumps: Present or Not?
0 1 2 3 4 5
0.25
0.50
0.75
1.00
GBP/USD (k=2)
EUR/USD (k=2) N(0,1)
2 0 2 4
0.25
0.50
EUR/USD (k=2) N(0,1)
USD/JPY (k=2) N(0,1)
2 0 2 4
0.25
0.50
USD/JPY (k=2) N(0,1) GBP/USD (k=2) N(0,1)
2 0 2 4
0.25
0.50
GBP/USD (k=2) N(0,1)
Figure 5: Empirical distributions of the nonstandardized (upper panels) and standardized (lower panels) test statistics
S
J
(p, k, ∆)
t
in Equation (7) for k = 2, p = 4, α = 4. The sample covers the periods from January 1, 2000 to March 12,
2010. The sampling frequency is 1minute. Under the null that there are no jumps, the test statistics in the upper panel
should converge in probability to 2.
0 1 2 3 4
0.25
0.50
0.75
EUR/USD (α=6)
Jumps: Finite or Infinite?
mean S
FA
=1.6237
0 1 2 3 4
0.25
0.50
0.75
EUR/USD (α=10)
mean S
FA
=1.7029
0 1 2 3 4
0.25
0.50
0.75
USD/JPY (α=6)
mean S
FA
=1.4429
0 1 2 3 4
0.25
0.50
0.75
USD/JPY (α=10)
mean S
FA
=1.5610
0 1 2 3 4
0.25
0.50
0.75
GBP/USD (α=6)
mean S
FA
=1.5869
0 1 2 3 4
0.25
0.50
0.75
GBP/USD (α=10)
mean S
FA
=1.7407
Figure 6: Empirical distribution of the nonstandardized test statistic
S
FA
(p, u, k, ∆)
t
in Equation (8) for the truncation
parameter α = 6 (left panels) and α = 10 (right panels). We set k = 2, p = 4. The sample covers the periods from
January 1, 2000 to March 12, 2010. The sampling frequency is 1minute. Under the null of ﬁnite activity jumps, the
test statistic should converge in probability to 2.
25
0.6 0.8 1.0 1.2 1.4 1.6 1.8 2.0 2.2 2.4 2.6 2.8 3.0
2
4
Brownian Motion: Present or Not?
Ho: Brownian Motion  Empirical histogram of S
W
EUR/USD
Brownian Motion Present
No Brownian
Noise Dominates
0 0.5 1 1.5 2 2.5 3 3.5 4 4.5 5 5.5 6 6.5 7 7.5 8
0.25
0.50
0.75
Jumps: Present or Not? EUR/USD
Ho: no jumps  Empirical histogram of S
J
No Jumps
Jumps Present
Noise Dominates
0 0.5 1 1.5 2 2.5 3 3.5 4 4.5 5 5.5 6 6.5 7 7.5 8
0.25
0.50
0.75
Jumps: Finite or Infinite? EUR/USD
Ho: finite activity  Empirical histogram of S
FA
Finite Activity Jumps
Infinite Activity Jumps
Noise Dominates
Figure 7: Characteristics of the EUR/USD returns. The sample covers the periods from January 1, 2000 to March 12,
2010. The sampling frequency is 1minute. Vertical bars denote the asymptotic probability limit of the statistics under
the respective null hypotheses.
QV due to Brownian motion
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
0.25
0.50
0.75
1.00
Quadratic variation of the EUR/USD
collapse of
Lehman Brothers
QV due to Brownian motion
QV due to jumps
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
0.25
0.50
0.75
1.00
QV due to jumps
QV due to big jumps
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
0.25
0.50
0.75
QV due to big jumps
QV due to small jumps
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
0.25
0.50
0.75
QV due to small jumps
Figure 8: The relative magnitudes of the continuous and jump components of the EUR/USD exchange rate. We ﬁx
p = 2, ̟ = 0.47, ǫ = 0.9 and α = 3. The sampling frequency is 1minute.
26
No correction (EUR/USD)
0 250 500 750 1000 1250
2
4
6
No correction (EUR/USD) WSD correction (EUR/USD)
0 250 500 750 1000 1250
2
4
6
WSD correction (EUR/USD)
No correction (USD/JPY)
0 250 500 750 1000 1250
2
4
6
No correction (USD/JPY) WSD correction (USD/JPY)
0 250 500 750 1000 1250
2
4
6
WSD correction (USD/JPY)
No correction (GBP/USD)
0 250 500 750 1000 1250
2
4
6
No correction (GBP/USD) WSD correction (GBP/USD)
0 250 500 750 1000 1250
2
4
6
WSD correction (GBP/USD)
Figure 9: The number of large increments (in logs) retained by 1{•} per intraday period for EUR/USD, USD/JPY and
GBP/USD returns. In the left panels, the truncation rate is constant over the day, u = α
√
BV
t
∆
̟
. In the right panels,
the truncation rate varies with intraday periodicity, u =
ˆ
f
WSD
t,i
α
√
BV
t
∆
̟
.
27
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